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International policies to address climate change have largely relied on market-based programs; for example, under the European Union's Emissions Trading Scheme (ETS) phase I (2005 to 2007) carbon dioxide emissions reductions were sought by setting a cap on each member state's allowable emissions and distributing tradable allowances to covered entities, such as power plants. Beginning operation in 2002, the Kyoto Protocol's Clean Development Mechanism (CDM) has relied on offsets, allowing certain industrialized nations to pay for emission reduction projects in developing countries--where the cost of abatement may be less expensive--in addition to reducing emissions within their borders. Legislative proposals to limit greenhouse gas emissions are under consideration in the United States. In this context, GAO was asked to examine the effects of and lessons learned from (1) the ETS phase I and (2) the CDM. GAO worked with the National Academy of Sciences to identify experts in market-based programs and gathered their opinions through a questionnaire, interviewed stakeholders, and reviewed available information.

According to available information and experts, the ETS phase I established a functioning market for carbon dioxide allowances, but its effects on emissions, the European economy, and technology investment are less certain. Nonetheless, experts suggest that it offers lessons that may prove useful in informing congressional decision making. By limiting the total number of emission allowances provided to covered entities under the program and enabling these entities to sell or buy allowances, the ETS set a price on carbon emissions. However, in 2006, a release of emissions data revealed that the supply of allowances--the cap--exceeded the demand, and the allowance price collapsed. Overall, the cumulative effect of phase I on emissions is uncertain because of a lack of baseline emissions data. The long-term effects on the economy also are uncertain. One concern about design and implementation was that the economic activities associated with emissions from covered entities would shift from the European Union to countries that do not have binding emission limits--a concept known as leakage. However, leakage does not appear to have occurred, in part because covered entities did not purchase allowances but received them for free. The effect of the ETS on technology investment also is uncertain but was likely minimal, in part because phase I was not long enough to affect such investments. Phase I of the ETS offers three key lessons: (1) accurate emissions data are essential to setting an effective emissions cap; (2) a trading program should provide enough certainty to influence technology investment; and (3) the method for allocating allowances may have important economic effects, namely, free allocation may distribute wealth to covered entities whereas auctioning could generate revenue for governments. According to available information and experts, the CDM has provided flexibility to industrialized countries with emission targets and has involved developing countries in efforts to limit greenhouse gas emissions, but the program's effects on emissions are uncertain, and its effects on sustainable development have been limited. Nonetheless, the CDM's effects reveal key lessons that can help inform congressional decision making. Specifically, the CDM has provided a way for industrialized countries to meet their targets that may cost less than reducing emissions at home; however, available evidence suggests that some offset credits were awarded for projects that would have occurred even in the absence of the CDM, despite a rigorous screening process. Such projects do not represent net emission reductions and can compromise the integrity of programs--including the ETS--that allow the use of CDM credits for compliance. We also found that the cost-effectiveness and overall scale of emission reductions are limited by the current project approval process, although proposed changes may improve its effectiveness. Key lessons from the CDM include: (1) the resources necessary to obtain project approval may reduce the cost-effectiveness and quality of projects; (2) the need to ensure the credibility of emission reductions presents a significant regulatory challenge; and (3) due to the tradeoffs with offsets, the use of such programs may be, at best, a temporary solution.

Matters for Congressional Consideration

Status: Closed - Implemented

Comments: Following the issuance of this report, and as part of its consideration of climate change legislation, GAO was asked to testify on topics addressed in our Matters for Congressional Consideration. Specifically, in 2009, GAO testified on three separate occasions at the invitation of Congress. These testimonies are summarized in the following three products: (1) In GAO-09-456T, we testified on the potential role of carbon offsets in climate change legislation, noting key lessons learned from the EU's use of the Clean Development Mechanism offsets program in the European cap-and-trade system. (2) In GAO-09-423T, we testified on the need for high quality greenhouse gas emissions data in establishing programs to address climate change, using illustrative information from the EU's experience in setting program baselines and emissions limits in its cap-and-trade program. (3) In GAO-09-950T, we discussed the benefits and drawbacks of various approaches for allocating tradable emissions permits, or allowances, under a cap-and-trade program, as well as various options for distributing revenue generated by the sale of these allowances. Findings in both areas were heavily informed by our work on GAO-09-151.

Matter: In deliberating legislation intended to limit greenhouse gas emissions that would employ a cap-and-trade system and developing policies that achieve the intended results in a cost-effective manner, Congress may wish to consider the importance of ensuring the availability and reliability of historic emissions data, with an accuracy compatible with the program's point of regulation, from entities that will be affected by the regulatory scheme prior to its establishment.

Status: Closed - Implemented

Comments: Following the issuance of this report, and as part of its consideration of climate change legislation, GAO was asked to testify on topics addressed in our Matters for Congressional Consideration. Specifically, in 2009, GAO testified on three separate occasions at the invitation of Congress. These testimonies are summarized in the following three products: (1) In GAO-09-456T, we testified on the potential role of carbon offsets in climate change legislation, noting key lessons learned from the EU's use of the Clean Development Mechanism offsets program in the European cap-and-trade system. (2) In GAO-09-423T, we testified on the need for high quality greenhouse gas emissions data in establishing programs to address climate change, using illustrative information from the EU's experience in setting program baselines and emissions limits in its cap-and-trade program. (3) In GAO-09-950T, we discussed the benefits and drawbacks of various approaches for allocating tradable emissions permits, or allowances, under a cap-and-trade program, as well as various options for distributing revenue generated by the sale of these allowances. Findings in both areas were heavily informed by our work on GAO-09-151.

Matter: In deliberating legislation intended to limit greenhouse gas emissions that would employ a cap-and-trade system or allow the use of carbon offset programs such as the Clean Development Mechanism, and developing policies that achieve the intended results in a cost-effective manner, Congress may wish to consider the importance of long-term certainty in encouraging investments in low-carbon technologies.

Status: Closed - Implemented

Comments: Following the issuance of this report, and as part of its consideration of climate change legislation, GAO was asked to testify on topics addressed in our Matters for Congressional Consideration. Specifically, in 2009, GAO testified on three separate occasions at the invitation of Congress. These testimonies are summarized in the following three products: (1) In GAO-09-456T, we testified on the potential role of carbon offsets in climate change legislation, noting key lessons learned from the EU's use of the Clean Development Mechanism offsets program in the European cap-and-trade system. (2) In GAO-09-423T, we testified on the need for high quality greenhouse gas emissions data in establishing programs to address climate change, using illustrative information from the EU's experience in setting program baselines and emissions limits in its cap-and-trade program. (3) In GAO-09-950T, we discussed the benefits and drawbacks of various approaches for allocating tradable emissions permits, or allowances, under a cap-and-trade program, as well as various options for distributing revenue generated by the sale of these allowances. Findings in both areas were heavily informed by our work on GAO-09-151.

Matter: In deliberating legislation intended to limit greenhouse gas emissions that would employ a cap-and-trade system and developing policies that achieve the intended results in a cost-effective manner, Congress may wish to consider the importance of understanding how the means of distributing allowances to emit greenhouse gases--such as free allocation versus auctioning--may create and redistribute substantial wealth.

Status: Closed - Implemented

Comments: Following the issuance of this report, and as part of its consideration of climate change legislation, GAO was asked to testify on topics addressed in our Matters for Congressional Consideration. Specifically, in 2009, GAO testified on three separate occasions at the invitation of Congress. These testimonies are summarized in the following three products: (1) In GAO-09-456T, we testified on the potential role of carbon offsets in climate change legislation, noting key lessons learned from the EU's use of the Clean Development Mechanism offsets program in the European cap-and-trade system. (2) In GAO-09-423T, we testified on the need for high quality greenhouse gas emissions data in establishing programs to address climate change, using illustrative information from the EU's experience in setting program baselines and emissions limits in its cap-and-trade program. (3) In GAO-09-950T, we discussed the benefits and drawbacks of various approaches for allocating tradable emissions permits, or allowances, under a cap-and-trade program, as well as various options for distributing revenue generated by the sale of these allowances. Findings in both areas were heavily informed by our work on GAO-09-151.

Matter: In deliberating legislation intended to limit greenhouse gas emissions that would allow the use of carbon offset programs such as the Clean Development Mechanism, and developing policies that achieve the intended results in a cost-effective manner, Congress may wish to consider that it may be possible to achieve the CDM's sustainable development goals and emissions cuts in developing countries more directly and cost-effectively through a means other than the existing mechanism.

Status: Closed - Implemented

Comments: Following the issuance of this report, and as part of its consideration of climate change legislation, GAO was asked to testify on topics addressed in our Matters for Congressional Consideration. Specifically, in 2009, GAO testified on three separate occasions at the invitation of Congress. These testimonies are summarized in the following three products: (1) In GAO-09-456T, we testified on the potential role of carbon offsets in climate change legislation, noting key lessons learned from the EU's use of the Clean Development Mechanism offsets program in the European cap-and-trade system. (2) In GAO-09-423T, we testified on the need for high quality greenhouse gas emissions data in establishing programs to address climate change, using illustrative information from the EU's experience in setting program baselines and emissions limits in its cap-and-trade program. (3) In GAO-09-950T, we discussed the benefits and drawbacks of various approaches for allocating tradable emissions permits, or allowances, under a cap-and-trade program, as well as various options for distributing revenue generated by the sale of these allowances. Findings in both areas were heavily informed by our work on GAO-09-151.

Matter: In deliberating legislation intended to limit greenhouse gas emissions that would employ a cap-and-trade system or allow the use of carbon offset programs such as the Clean Development Mechanism, and developing policies that achieve the intended results in a cost-effective manner, Congress may wish to consider that the use of carbon offsets in a cap-and-trade system can undermine the system's integrity, given that it is not possible to ensure that every credit represents a real, measurable, and long-term reduction in emissions.

Status: Closed - Implemented

Comments: Following the issuance of this report, and as part of its consideration of climate change legislation, GAO was asked to testify on topics addressed in our Matters for Congressional Consideration. Specifically, in 2009, GAO testified on three separate occasions at the invitation of Congress. These testimonies are summarized in the following three products: (1) In GAO-09-456T, we testified on the potential role of carbon offsets in climate change legislation, noting key lessons learned from the EU's use of the Clean Development Mechanism offsets program in the European cap-and-trade system. (2) In GAO-09-423T, we testified on the need for high quality greenhouse gas emissions data in establishing programs to address climate change, using illustrative information from the EU's experience in setting program baselines and emissions limits in its cap-and-trade program. (3) In GAO-09-950T, we discussed the benefits and drawbacks of various approaches for allocating tradable emissions permits, or allowances, under a cap-and-trade program, as well as various options for distributing revenue generated by the sale of these allowances. Findings in both areas were heavily informed by our work on GAO-09-151.

Matter: In deliberating legislation intended to limit greenhouse gas emissions that would allow the use of carbon offset programs such as the Clean Development Mechanism, and developing policies that achieve the intended results in a cost-effective manner, Congress may wish to consider that while proposed reforms may significantly improve the CDM's effectiveness, carbon offsets involve fundamental tradeoffs and may not be a reliable long-term approach to climate change mitigation.